Contents

Outside Directors and CEO Selection
Kenneth A. Borokhovich, Robert Parrino, and Teresa Trapani

Measuring Rents and Interest Rate Risk in Imperfect Financial Markets: The Case of Retail Bank Deposits
David E. Hutchison and George G. Pennacchi

What Do Stock Splits Really Signal?
David L. Ikenberry, Graeme Rankine, and Earl K. Stice

The Impact of Industry Classifications On Financial Research
Kathleen M. Kahle and Ralph A. Walkling

Evidence on Corporate Hedging Policy
Shehzad L. Mian

Abstracts

This paper examines the use of seven mechanisms to control agency problems between managers and shareholders. These mechanisms are: shareholdings of insiders, institutions, and large blockholders; use of outside directors; debt policy; the managerial labor market; and the market for corporate control. We present direct empirical evidence of interdependence among these mechanisms in a large sample of firms. This finding suggests that cross-sectional OLS regressions of firm performance on single mechanisms may be misleading. Indeed, we find relations between firm performance and four of the mechanisms when each is included in a separate OLS regression. These are insider shareholdings, outside directors, debt, and corporate control activity. Importantly, the effect of insider shareholdings disappears when all of the mechanisms are included in a single OLS regression, and the effects of debt and corporate control activity also disappear when estimations are made in a simultaneous systems framework. Together, these findings are consistent with optimal use of each control mechanism except outside directors.

Outside Directors and CEO Selection
Kenneth A. Borokhovich, Robert Parrino, and Teresa Trapani

This paper documents a strong positive relation between the percentage of outside directors and the frequency of outside CEO succession. The likelihood that an executive from outside the firm is appointed CEO increases monotonically with the percentage of outside directors. This monotonic relation is observed for both voluntary and forced departures. Evidence from stock returns around succession announcements indicates that, on average, shareholders benefit from outside appointments, but are harmed when an insider replaces a fired CEO.

Measuring Rents and Interest Rate Risk in Imperfect Financial Markets: The Case of Retail Bank Deposits
David E. Hutchison and George G. Pennacchi

Traditional measures of interest rate risk assume that prices of financial assets and liabilities are set in perfectly competitive markets. However, evidence suggests that many retail financial markets do not follow the competitive paradigm. In this paper we employ a general contingent claims framework to value rents earned by banks in demandable retail deposit markets. Our analysis provides a natural and economically meaningful measure of interest rate risk for these imperfectly competitive markets. Using monthly survey data on NOW accounts and MMDAs, we estimate the value of retail deposit rents and deposit durations for over 200 commercial banks.

What Do Stock Splits Really Signal?
David L. Ikenberry, Graeme Rankine, and Earl K. Stice

We observe significant post-split excess returns of 7.93% in the first year and 12.15% in the first three years for a sample of 1,275 two-for-one stock splits. These excess returns follow an announcement return of 3.38%, indicating that the market underreacts to split announcements. The evidence suggests that splits realign prices to a lower trading range, but managers self-select by conditioning the decision to split on expected future performance. Pre-split runup and post-split excess return are inversely related, indicating that our results are not caused by momentum.

The Impact of Industry Classifications On Financial Research
Kathleen M. Kahle and Ralph A. Walkling

Using approximately 10,000 firms jointly covered by Compustat and CRSP from 1974-1993, we find substantial differences in the SIC codes designated by the two databases. Over 36% of the classifications disagree at the two-digit level and nearly 80% disagree at the four-digit level. We examine the impact of these differences upon financial research in several ways. First, we show that the classification of utilities, financial firms, and conglomerate acquisitions are affected by the choice of CRSP versus Compustat SIC codes. Second, we show that industry classification matters in financial research by illustrating that size and industry matched comparisons are more powerful than pure size matches. Third, we test the specification and power of Compustat versus CRSP classifications by simulating a typical financial experiment in which sample firms are matched to control firms by industry. We find that: (1) Compustat matched samples are more powerful than CRSP matched samples in detecting abnormal performance, (2) non-parametric tests outperform parametric tests, and (3) four-digit SIC code matches are more powerful than two-digit SIC code matches. These results are robust to the inclusion or exclusion of extreme values, and hold for both NYSE/AMEX and Nasadaq firms.

Evidence on Corporate Hedging Policy
Shehzad L. Mian

This paper provides empirical evidence on the determinants of corporate hedging decision. The paper examines the evidence in light of currently mandated financial reporting requirements, in particular the constraints placed on anticipatory hedging. Data on hedging are obtained from 1992 annual reports for a sample of 3,022 firms. Out of the 771 firms classified as hedgers, 543 firms disclose information in their annual reports on their hedging activities; the remaining 228 firms report use of derivatives but no information on hedging activities. Based on the evidence, I draw the following conclusions with respect to the models of hedging: (a) evidence is inconsistent with financial distress cost models, (b) evidence is mixed with respect to contracting cost, capital market imperfections, and tax-based models, and (c) evidence uniformly supports the hypothesis that hedging activities exhibit economies of scale.